ALLL Insiders / Justification of Qualitative and Environmental (Q/E) Considerations

Written By: John Lane

As required by regulatory and accounting guidelines, historical loss experience is the starting point for estimating future loss expectations. In a stable environment without significant changes in process, personnel, or portfolio concentration, historical experience offers a reasonable approximation of expected future losses. However, a constantly changing environment requires management to assess how changes may affect future losses.

 

 

At First Citizens Banc Corp, Management has identified a group of metrics in order to monitor changes in the business climate that may impact how the Bank chooses to allocate reserves. The data points chosen by Management provide directional and quantifiable information to inform decisions about whether the existing Qualitative/Environmental (Q/E) adjustments are consistent with and account for the changes occurring within the Bank’s footprint. Given the uncertainty and inherent imprecision of estimating future losses, Management utilizes the same data points from period to period in order to ensure decision making remains consistent and justifiable.

Management looks at changes in the risk considerations of the nine qualitative and environmental factors as outlined by guidance. First Citizens uses multiple indices and reference points to justify each qualitative factor. Those data points include the following:

1. Changes in national and local economic and business conditions, including the condition of various market segments
   • The Conference Board Leading Economic Index® (LEI)
   • The Conference Board Coincident Economic Index® (CEI)
   • The Conference Board Lagging Economic Index® (LAG)
   • Manufacturing ISM Report On Business®
   • Industrial Production and Capacity Utilization – G.17
   • Coincident Economic Index (for Ohio)
   • Unemployment
   • The Federal Reserve Beige Book
2. Changes in lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices
   • Policy updates and/or reviews
   • Process changes, especially around criticized asset review
3. Changes in experience, ability and depth of lending management and staff
   • Promotion of key personnel
   • Hiring or changes in staff composition that affect loan quality
   • Key personnel training in credit skills
   • Ongoing training to maintain credit and lending skills
4. Changes in the nature and volume of the portfolio and in the term of the loans
   • Loan type growth that has occurred within loss history timeframe as a percent of total loan growth
   • Average loan size
   • Change in product types
   • Acquired loans
5. Changes in the quality of the bank’s loan review system and degree of oversight by the bank’s Board of Directors
   • Internal loan review policy and quantifiable trend in upgrades or downgrades
   • External loan review activity and quantifiable trend in upgrades or downgrades
   • Exam results and quantifiable information related to loan quality
6. Changes in the underlying collateral for collateral dependent loans
   • Trend in appraised values of criticized loans
   • Case-Schiller Index
7. Changes in volume and severity of past due loans, non-accrual loans or criticized loans
   • Trend in level of impaired, classified and criticized loans
   • Level of criticized loans as a percent of the portfolio and relation to historical levels
   • Peer comparison of nonaccrual loans
8. The effect of external factors such as competition and regulatory requirements on the level of estimated losses
   • RMA Risk Assessment
   • Lending Surveys
   • Internal Management Surveys
9. The existence and effect of any concentrations of credit and changes in the level of concentrations
   • Quarterly concentration assessment as compared to regulatory thresholds and historical averages
   • Concentrations as related to Concentration Policy thresholds
   • Concentrations as related to Capital Plan
   • Data related to CRE performance within the Bank’s area of business (i.e. Co-Star reports or other sources)

By consistently checking a set group of data points, the management team at First Citizens Banc Corp feels that informed judgments can be made about necessary adjustments to the allocation of reserves without creating a rigid matrix that may not appropriately account for the dynamic business environment or climate. Consistency has resulted in taking some of the “guess work” out of the Q/E process and has allowed Management to effectively communicate the reasons for adjustments with minimal misunderstanding.

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